I. Functions of
MoneyA.Medium
of exchange: facilitate exchange eliminating barter which requires people
with mutually needs.B. Standard of value: allows for
the pricing of heterogeneous goods.C. Store of value: maintains
value and provides liquidity so extra spending power is
available as needed.Maintaining money's value requires 1. A sound fiscal
policy (a reasonable federal debt) 2. A sound monetary policy
(not using inflation to pay the federal debt)
3. A brief history of U S dollar debasement?D. Standard of deferred payment:
makes credit contracts possible so credit
transactions are possible.

II. The Supply and Demand for
MoneyA. Three categories of the
supply of money1.
M1 = Currency, coins, and demand deposits (checking accounts).
2. M2 = M1 plus near
monies such as small time deposits (savings
accounts) and short-term government
securities.
3. M3 = M2 plus large
time deposits (over $100,000)B. What backs the dollar? 1.
In 1971 President Nixon took the U.S. off a partial gold standard. See
The
Gold Reserve Act2.
It is a debt of the federal government.3.
Backed by faith in the government's ability to control inflation.4.
Value is determined by acceptability (it is legal tenderand
scarce).5.
Commodity money,
such as tobacco used as money in the Virginia colony,
has
intrinsic
value of its own. 6.
It's fiat (by decree of the government) money.
a. Fiat money's first appearance in the U.S. when
Congress issued Continental currency
with no gold backing
1.
Gresham's Law(bad money chases good) caused it to
disappear after the war.
2. State issued their own money.
3.
Ben Franklin and Paper Money Economy
b. Greenbacks
(demand notes on the Treasury) that were green in color were issued as
legal
tender during the Civil War.
c. An intermittent return to
Gold
Standard (only gold is money) followed although the U.S.
left gold for good in 1971as high inflation caused a run on gold that
the U.S. Treasury
could not satisfy. 7.
Today, coins have little intrinsic value (a small % of face value)so
they are called token money.9.
Types of money has more information

Continental
Currency

Hyperinflation
in the Weimar Republic

A 50,000,000 (50 million) mark banknote from 1923 Germany

C. The Demand for Money
1. Transaction D, Dt,
results because people hold money,
often in
a money market
account, to use as a medium of exchange.
2. Asset Demand, Da,
results because people accumulate
money,
often held in an
investment account,
to buy assets.
3. The demand for money Dm= D t
+ Da
4. Interest rates are set in
the money market. more interesting history.
5.
For more information visitDemand for money

III. United
States Private Banking SystemA. Two kinds of banks1.
Commercial banks offer demand deposits (checking accounts)2.
Savings and loan associations used to specialize in time
deposits
(saving
accounts) and home mortgages. Now, because
of deregulation during the early 1980's, they are similar to
commercial banks.
B. Federal deregulation contributed to banking
difficulties in the 1980's.
C. Visit History
provided
by the Federal Reserve Bank of St. Louis for
a time line of the U.S. banking System. Be sure to point at each
date
to see what happens during that period.

1. Board of Governors oversee the Federal Reserve Systema. Seven governorsb. Governors are appointed by the President and confirmed by the
Senate.
c. The
chair is appointed by the President for a four-year term.
1) To foster independence, the term does not coincide with the President's
term.
2) Other board members are appointed to
14-year terms on a staggered
basis to insure an experienced board. 2. Federal Open Market Committeea. Membership consists of the Board of Governors and 5 of the 12 Federal
Reserve bankpresidents with the N.Y. president always a member
becauseN.Y. City
is the financial center for U.S. international trade.b. The Committee tries to affect interest rates by affecting the supply of
money by buying
and selling U.S. government bonds (See Chapter 15).3. Federal Advisory Council12
prominent commercial bankers, one from
each district, who
advise the Board of Governors
4. Twelve Federal Reserve Banks a. The United States is divided into 12 homogenous districts and each
has
its own bank b. Bank for the federal governmentc. Bank for member banks
d. Graphic is complements of the Board of Governors of the Federal
Reserve System.
5.
Member commercial banks6. Nonmember commercial banks and thrifts are regulated byother
government agencies.

Federal Open Market
Committee
meeting at the Federal Reserve in Washington, DC

20th Century
U.S. Political Economy
ConciseInteraction of Politics
and Economics

V. Recent Developments
A. Banks and thrifts are the only
institutions whose checking accounts are not
restricted as to check size and number
1. The Financial Institutions Reform, Recovery and
Enforcement Act of 1989,
liberalized banking laws, caused a declined in their importance although
reforms resulting from the Great Recession of 2008 cold change this.
2.
Consolidation has caused their numbers to decline and their size to
increase.
3. Many
bank/thrift services are now performed by insurance companies,
pension, and securities companies.
B. Globalization of financial
markets.
C. Shadow Banking
System
1.
Rise of the Shadow-Banking System
2. Long
Term Capital Management collapsed in the late 1990s
D. Some politicians think the Federal
Reserve system is too independent.
1.
Congress Is Politicizing the Fed
Jan 25, 2010
2.
Central bank independence versus inflation
This often cited[49] research published by Alesina and Summers (1993)[50]is used to show why it is important for a nation's central bank (i.e.-monetary
authority) to have a high level of independence. This chart shows a clear
trend towards a lower inflation rate as the independence of the central bank
increases. The generally agreed upon reason independence leads to lower
inflation is that politicians have a tendency to create too much money if
given
the opportunity to do it.[50]
The Federal Reserve System in the United States
is generally regarded as one of the more independent central banks.
3.
Presidential Elections of 1828 and 1832were about the need
for a strong central bank

VI.Fractional Reserve System/Creation of Money A. Commercial banks are
required to keep a reserve (cash) of about 12% of their
demand deposits
(checking accounts) at their bank or on
deposit
with the
Federal Reserve (required reserves). The remainder, (Excess
Reserves)
may be loaned out even though they support deposits.
B. Money is created by these loans as long as the
demand deposits (DD) created
by them stay within the banking system, that is,
the money loaned is redeposit
as a DD into a
bank within the system. The banks owe the demand deposits
created
by the loans
to each other. These inter-brain debts are canceled with
a
bookkeeping entry. It should be pointed
out that the demand deposits
created by such loans are spent, and goods transferred,
just as if the
transaction involved currency.
C. Example: Bank A has $50,000 in
demand deposits. A reserve requirement of
10% would yield required reserves of
.10 x $50,000 = $5,000. If Bank A
had $7,000 in
reserve, it could loan up to $2,000 in the form of demand
deposits. Suppose Bank
B does exactly the same with both banks' customers
depositing their DD in the other bank. Banks would owe cashed checks to
each
other, would cancel interbank debts, and money has been created.
D. The system works in reverse
with money destroyed if reserves leave the system.
E. Required reserves, reserves
not loaned, and loans of cash (reserves) represent
a leakage which
eventually stops money
supply growth.
F.
Readings and Video1.
The Truth is Out: Money is Just an IOU and the Banks are Rolling In Tt
2.
Money Creation in the Modern Economy
3.
Money Creation Video 13.03 minutes is well done